Sept 12, Colombo: Most Sri Lankan non-life insurers should be able to absorb near-term volatility and the effects of adverse weather-related events given extensive use of reinsurance, says Fitch Ratings.

However, frequent occurrence of major catastrophic floods could affect insurers' capital, especially that of state-owned local reinsurer, National Insurance Trust Fund Board (NITF, AA-(lka)/Stable).

Changing weather patterns have increased the frequency and severity of errant rainfall, raising long-term risks for insurers and highlighting the need for more rigorous pricing and assessment of such risks in Sri Lanka's highly competitive non-life sector.

Sri Lanka experienced back-to-back floods and landslides in May 2016 and May 2017. NITF estimates claims of around Rs. 4 billion from the May 2017 floods, which mainly affected suburban and rural areas, significantly lower than claims of around Rs. 17 billion from the May 2016 floods, which predominantly affected industrial areas, with a handful of large commercial claims accounting for a large share of the total. However, despite these large claims, we estimate the net impact on non-life insurers due to the May 2016 floods to have been around Rs. 500 million-600 million, mainly from retention and reinstatement costs. These costs were likely to have added around 70bp to non-life insurers' loss ratios in 2016. The floods, which left hundreds dead, damaged homes and disrupted businesses, were the country's worst natural catastrophe since the 2004 south-Asian tsunami.

Local regulations require 30% of all non-life reinsurance be ceded to NITF, with the balance ceded to the international reinsurance market. NITF's reinsurance portfolio is protected via retrocession cover, which has helped contain losses from the record-high flood-related primary insurer claims. NITF has provided the Sri Lankan government with natural disaster cover since April 2016 - the National Natural Disaster Insurance Scheme (NNDIS) - which covers all households, small businesses and relief work stemming from natural disasters. Cover was increased to Rs. 15 billion for 2017-2018, from Rs. 10 billion, with total claims of around Rs. 3.8 billion in 2016 and Rs. 1.6 billion in 2017. NITF recovered Rs. 2.6 billion in 2016 via NNDIS's reinsurance cover that was in place for 2016-2017; that is, after a deductible of Rs. 500 million, which was retained by the company, as well as NITF's share of claims on NNDIS's reinsurance cover.

However, a delay in government approval meant NITF's reinsurance cover for NNDIS for 2017-2018 only came into effect after the May 2017 floods, resulting in a Rs. 600 million loss, as the deductible (company retention) was raised to Rs. 1 billion. NITF, as a state-owned entity, must go through a state procurement committee to obtain reinsurance, which can be time consuming. NITF has satisfactory capital buffers to absorb flood-related net losses of Rs. 2.2 billion for 2016 and RS. 3.1 billion for 2017, with a high regulatory risk-based capital ratio of 558% at end-March 2017. However, capitalization could come under pressure if NITF continues paying high dividends to the government. NITF paid Rs. 3.2 billion in 2016 and Rs. 3 billion in 2015, which accounted for 103% and 70% of profit, respectively.

Sri Lanka's non-life insurers have low retention in the non-motor segment, with over 80% of the fire class, which typically covers flood-related policies, being reinsured. Fire class accounted for around 2% of total non-life net written premiums (NWP) in 2016. Insurers also provide flood protection for the motor class (75% of NWP in 2016), but motor-related claims were smaller than under the fire class. Natural catastrophe losses, such as floods, are covered under reinsurance treaties and excess-of-loss reinsurance covers.